Bilge Erten and José Antonio Ocampo

Initiative for Policy Dialogue, October 18, 2013

Abstract

This paper examines whether capital account regulations are effective in reducing foreign exchange pressure and real exchange rate appreciation. Using four indices of capital inflow regulations, foreign exchange-related regulations, financial sector specific restrictions, and capital outflow regulations for 51 emerging and developing economies over the period 1995-2011, we find that all policy measures except financial sector specific restrictions are associated with lower foreign exchange pressure and reduced real exchange rate appreciation, and that the effects of capital outflow regulations are larger in magnitude than those on capital inflows. We also find that capital account regulations enhance monetary policy autonomy by reducing the effect of interest rate differentials on nominal exchange rates. Our results further indicate that increasing the restrictiveness of capital account regulations in the run-up to the crisis reduced the growth decline during the crisis, thus enhancing crisis resilience, and that countries that used capital account regulations experienced less overheating during post-crisis recovery when there was a new surge in capital inflows. The latter two results imply that capital account regulations are a powerful counter-cyclical policy instrument.

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